The interaction between IRAs and 401(k) plans in savers’ portfolios

Policy makers have long sought to boost households’ preparation for retirement through a variety of tax incentives, including Individual Retirement Accounts (IRAs), 401(k) plans, and other options. The impact of such policies, studied individually, on private and national saving, has led to an extensive literature.

There is little evidence, however, on how the policies interact with each other. To what extent are the retirement programs substitutes or complements? Does eligibility or participation in one such program boost or reduce participation in other similar programs? The programs might logically be thought to be substitutes, since they provide a similar good – a tax incentive for retirement saving. The law essentially treats them as substitutes since the contribution limit of traditional IRAs is lowered by access to an employer-sponsored plan. But it would not be unreasonable, a priori, to consider that they might instead be complements – that is, that eligibility or saving in one form could “crowd in” saving in other forms. This could occur, for example, if eligibility for one form of saving made people more aware of the need to save for retirement and they subsequently responded by saving more in several tax-preferred vehicles.

These issues are of relevance to policy makers because of the perennial focus on ways to raise retirement saving and because of the budgetary costs associated with tax expenditures for saving, with current estimates exceeding $100 billion per year. To the extent that the different tax incentive programs are complements, exposing a worker to one program could raise participation in several programs. To the extent that the programs are substitutes, expansion of one program might cannibalize contributions to the other.

In “The Interaction Between IRAs and 401(k) Plans in Savers’ Portfolio” (PDF), William Gale, Aaron Krupkin, and Shanthi Ramnath examine the interaction between IRAs and 401(k) plans in savers’ portfolios – and in particular, the question of whether the programs act as substitutes or complements – using administrative tax data.

A well-recognized problem in the earlier literature on saving incentives is that needs and tastes for saving are heterogeneous across the population. Households with strong tastes or needs for saving may be more likely to save in many forms than those with weak tastes or needs for saving. Not controlling for this heterogeneity will bias analysis toward finding that different forms of retirement saving are complements even if they are not. To address this problem, the authors use two different control groups in their analysis. As explained below, one control group plausibly has stronger average needs or tastes for saving than the treatment group, while the other control group plausibly has weaker average needs or tastes for saving than the treatment group. Their results, however, are not sensitive to which control group is employed. In comparisons of their treatment group with either control group, the authors find little or no complementarity or substitutability between 401(k) contributions and IRA contributions. As a result, contributions to the two forms of saving appear to be independent.

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  • Footnotes
    1. See Benjamin (2003); Bernheim (2002); Chetty et al. (2014); Engen, Gale, and Scholz (1996); Engen and Gale (2000); Hubbard and Skinner (1996); Poterba, Venti, and Wise (1996).
    2. The U.S. Department of the Treasury (2016) calculates tax expenditures for retirement programs in two ways. The first estimates current-year revenue losses from all existing accounts. The second examines the present value of revenue loss from all new contributions in a given year. Both procedures yield annual revenue loss estimates above $100 billion in recent years.